UK feels Brexit pressure after EU-Japan trade deal

The signing of the EU-Japan Economic Partnership Agreement in July put into sharp contrast the UK's struggles to make any tangible progress with its Brexit negotiations. Jacopo Dettoni assesses how Japanese companies will view their European investments should the UK head for a no-deal Brexit.

As Brexit blurs the horizon of the UK’s future foreign trade policies, the EU finalised a major trade deal with Japan in July, thus creating the world’s largest open economic area. With the chance of a no-deal Brexit increasing as the March 2019 deadline approaches, Japanese investors are now facing the dilemma of doing business within a free-trade area that stops at British shores. This casts additional uncertainty around the future of their investments in the UK, which are responsible for thousands of jobs.

“Brexit is quite disturbing, especially for Japanese car manufacturer and infrastructure companies that have invested heavily in the UK in recent decades. Those investments were made under the assumption that the country would remain in the single or common market,” says Hosuk Lee-Makiyama, director of the Brussels-based European Centre for International Political Economy.

The current political uncertainty is a concern. “Japanese businesses generally shy away from uncertainty. They sometimes prefer legal certainty even when the regulatory situation is complex. The trade deal is now going to have a major impact,” says Mr Lee-Makiyama.

Mayday for the UK

The EU and Japan wrapped up months of negotiations when they signed the EU-Japan Economic Partnership Agreement (EPA) on July 17 – just over a week after Theresa May’s UK government lost two cabinet ministers. Chief Brexit negotiator David Davis and foreign minister Boris Johnson resigned following long-standing friction over Ms May’s vision of Brexit, which the cabinet has agreed to at the prime minister’s Chequers residence.

The plan proposes that the UK retain, among other things, a common rulebook leading to continuous rule harmonisation with the EU after Brexit and a facilitated customs arrangement with the EU that would avoid the return of a hard border between Northern Ireland and Ireland.

It failed to impress long-time Brexiteers Mr Davis and Mr Johnson, however, who are pushing for a 'hard Brexit'. The latter even labelled the Chequers plan as a “miserable, permanent limbo” in his resignation speech at the House of Commons.

A Japanese retreat?

Against this backdrop of continued uncertainty, the new EU-Japan EPA has the potential to alter the perspective of Japanese investors that have been a significant source of foreign investment into the UK for years. Japanese companies have set up major production facilities particularly in the automotive sector in the UK. Nissan alone has invested £3.7bn ($4.76bn) in its facility in Sunderland, north-east England, since 1984, and it still employs 6700 people.

“Even if the UK signs a trade deal with Japan that is a replica of the deal Japan signed with Europe, we will be looking at some relocation of manufacturing resources out of the UK. I think that’s inevitable,” says Mr Lee-Makiyama.

“It won’t be possible to serve the single market out of the UK unless you have a very soft form of Brexit that at least contains a customs union. Under a reasonably assumable scenario of Brexit, businesses trading with the EU bloc will face the same trading costs from Nagoya as they would do from Sunderland, but the question on whether that investment stays in the UK or not depends on what kind of Brexit you will have.”

No deal looms

But the question of what kind of Brexit the UK is heading for has gone unanswered since the referendum in 2016. As the March 2019 deadline for the UK to exit the EU approaches, with a whole new negotiating team and strategy in place, the chances of a no-deal leading to an abrupt reinstatement of World Trade Organization tariffs immediately with no transition period “have become uncomfortably high”, the governor of the Bank of England, Mark Carney, told the BBC on August 4.

“Companies such as Honda and Nissan rely on global supply chains,” Paola Conconi, visiting professor at the London School of Economics, wrote in February 2018. “Right now, they can automatically sell the cars they produce in the UK to the rest of the EU at zero tariffs.

“In the case of a UK-EU free-trade agreement, they would face a trade-off. If they decide to remain in the UK [they would have to] stop importing key components from Japan and other non-member countries to comply with rules of origin and obtain duty-free treatment, or keep their global value chains in place, but face a 10% tariff when exporting their cars from the UK to the EU. Relocating to continental Europe would allow them to remain in the customs union, avoiding this trade-off.”

UK hitting the brakes?

Although the UK government appears to be in a state of disarray over the Brexit negotiations, it has often been vocal in its support to existing foreign investment in the country. Ms May reportedly offered Nissan a written commitment of extra support in late 2016 should Brexit reduce the competitiveness of its Sunderland plant. Nissan’s management has been quiet over the ongoing negotiations with the government, though some of their peers have been more vocal about their concerns.

“If, at the end of the day, the supply chain will have a stop at the border, then we cannot produce our products in the UK,” BMW customs manager Stephan Freismuth told the Financial Times in June. BMW employs about 7000 people in a four factories across the UK, including those producing the Mini and Rolls-Royce models.

Jaguar Land Rover – now the UK’s biggest car producer thanks to new owner Tata's major investment plan over the past 10 years – told the Financial Times in July that a hard Brexit would cost the company £1.2bn in tariffs every year, and jeopardise the future of an £80bn, five-year investment plan.

If contingency plans have not been triggered yet, the current uncertainty has already taken a toll on the UK’s investment appeal. First, inflows of foreign capital spiked after the June 2016 referendum, as bargain hunters saw big opportunities in the sudden depreciation of the pound that followed the vote. These inflows then started to plummet. Headline FDI fell to $15.1bn in 2017, the lowest level since 1994, according to Unctad figures.

Some investors have swum against the tide, including Japanese entrepreneur Masayoshi Son, who bought British chipmaker ARM Holding a few weeks after the referendum through his booming investment holding Softbank. However, the political environment in the UK remains as uncertain as ever, with the government receiving criticism for sending out mixed signals. On the one hand, it is reassuring the business community over the final outcome of the negotiations; on the other, it is talking of stockpiling medicine and food to cope with possible shortages in the event of a hard Brexit.

Both Brussels and the UK have another few months to clear the way for a Brexit deal, or the potential lose-lose outcome of a 'no deal' will become reality.

Corporate location benchmarking tool

fDi Benchmark is the only online tool to benchmark the competitiveness of countries and cities in over 50 sectors. Its comprehensive location data series covers the main cost and quality competitiveness indicators for over 300 locations around the world.